In the same table which Schweser got wrong for Profit Margin, because it didn’t allow for the inclusion of Minority Interest in Equity (rather than Shareholders’ Equity) under Consolidation, it states correctly that Leverage increases from Equity through Prop Consolidation to to the Consolidation method. How come they got this right if they thought Equity and Assets & Debts all scaled up proportionally between the two Consolidation methods? I’m not being overly-curious at this stage in the game, just wondering if I’m missing something else about the Consolidation process…
Leverage - is Total Assets / Equity Look at what it was before Equity included Minority interest. Equity was same in all methods. Total Assets went up – C > PC > E So TA/E - Fin Leverage C > PC > E. So even without the E portion including NCI - that ratio effect was ok.
cpk123, I agree Total Assets go up, but shouldn’t Equity go up too? If I consolidate a simple $100 company made up only of Assets (and everything at fair & book value) I should increase my assets by $100, but also my Equity. Otherwise the accounting equation doesn’t balance, no? If it’s proportionate consolidation and I’m buying 60% of the company I add $60 to both my Assets and Equity. My final ratio (aggregating my own situation before the purchase with the purchase) will be different depending on the method, but whether higher or lower should depend on the whether the subsidiary’s ratio was higher or lower than my original one.
Assets go up 100 Liabs go up less than 100 - because you have the minority interest in Equity, remember… so E would go up less than 100. based on A+100/E+say 90 —> u have higher leverage.
Thanks, cpk123, but I think I’ve just figured it out. My first post confusedly said that I thought Schweser got it right to say Consolidation would have the highest leverage despite not taking account of MI. BUT Equity is higher with MI, so the ratio would actually be lower than otherwise had Schweser been aware of the issue. Still, I wasn’t quite getting why the leverage was different (MI issues aside) between Prop Con & Con. I’m not sure if this is another way of saying what you’re saying, but it comes down to cash paid - I was aggregating assets, etc, without reducing anything to allow for payment! So new Assets and Liabilities both go up in the same proportion between the two Consolidation methods, BUT there is an equal Asset reduction from the cash outlay, which is proportionately smaller to the new assets under full Consolidation. Thus, excepting MI, Leverage increases. MI now becomes interesting, because it is at least partially off-setting. Is the increase in Equity (the denominator) from MI enough to bring down leverage to the same or lower levels as under Prop Cons? Well, the slightly fictional asset increase from full Consolidation should roughly equate (I’m not considering Goodwill here) in the numerator to the increase in the Equity denominator (from MI), assuming no debt. The leverage effect will depend then on the leverage of the company acquired compared to the parent’s. If I’m right it’s tricky enough that we should not casually assume anything about the leverage effect of Consolidation.